Europe, Australia and Asia have the most developed and diversified bond markets. Emerging markets(EM)have been a hot spot and have outperformed other destinations in the past decade, even with the recent turmoil. Credit conditions have improved, and many former EM countries are now part of some investment grade benchmarks (e.g., Russia and Mexico). Monitor your benchmark selection and risk tolerance carefully. Be prepared for more adventurous travel in the EM world, which may still be subject to political upheaval and contagion. Also, sovereign EM debt is giving way to corporate issuance, which requires more due diligence.
Rather than committing a fixed portion of your assets to EMs, invest a small allocation (up to 5% per allocation, with an overall cap)as part of a global mandate.
Travelling alone or in a group
Do you take the group tour with a global manager who can invest across markets and asset classes(e.g., sovereign debt, high yield)or take along your backpack and tour book and choose niche players in specific sectors and markets? Choosing specialist managers means that more asset allocation decisions need to be made by your Board. Giving the asset allocation responsibilities to a manager, however, may be the best solution for many plans.
What to pack
Review your SIP&P(Statement of Investment Policies & Principles)thoroughly, outlining approved and disallowed assets, countries and strategies. Ensure that currency hedging policies are well defined. And if you plan to make use of derivatives, clarify the definition of leverage. For example, many global managers use swaps and futures rather than cash bonds to execute duration strategies and invest the asset in “cash plus” strategies such as lower quality or six- to nine-month securities rather than staying in the traditional short-term AAA cash markets.
Budget
Be prepared for higher active management fees. Expect 50 basis points or more for an active global manager.
Shopping around
Canadian credit sectors are poorly diversified, with nearly 50% in the financial services industry. Global markets offer a wide range of sectors, products and strategies that can improve the portfolio risk/reward profile compared to a purely domestic selection.
U.S. subprime mortgages are lurking in many structured credit products(e.g., asset-backed commercial paper), and poor disclosure makes these sectors worrisome. However, higher-quality foreign bonds relating to prime mortgages can still be an excellent source of high-quality assets.
Travel log
Reporting to the Board and monitoring managers become more complex as you diversify. Ask managers for performance records.
With appropriate diversification, global strategies can reduce portfolio risk and potentially yield significant rewards. Whether you’re a first-time adventurer or a seasoned traveller, preparation is key.
Investment Travel Checklist Board education and SI P&P: Asset classes, strategies, derivatives, currency risk, leverage, risk/reward, benchmark. Benchmark selection: Domestic liabilities, domestic benchmark, foreign benchmark hedged to CAD dollars or foreign benchmark unhedged. Fees: Active fees are higher than most domestic managers. Domestic versus foreign managers: Many domestic managers have the expertise, team and tools for global yield curve strategies, high-quality credit and some derivatives, and a few for high-yield bonds. Foreign managers may have larger teams to support credit strategies across more markets. Specialist versus global managers: Niche players require the Board to make more asset allocation decisions. Bigger players may add value through sector selection. Reporting: Look for detailed performance attribution reports to determine |
Marlene K. Puffer is managing director at Twist Financial Corp. in Toronto. marlene.puffer@twistfinancial.com
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